Asia Insight: Assessing India and China

Extracts from analysis by Sunil Asnani, Research Analyst
Matthews International Capital Management, LLC
Extracts from two Newsweek articles

Introduction

There are significant contrasts between India and China. Matthews Investment Group invests in both. Nevertheless, there are significant differences and these must be taken into account in determining allocation. First, China has a higher growth rate, but that growth can be more volatile. That doesn't stop investors, some of whom will do anything for growth because it certainly is not robust on the other side of the globe.

India seems to be on a relatively sustainable growth path, one that is not as volatile. That stability has not always been seen by investors. During the recent global recession, India's gross domestic product growth fell to 6% from 9%. On the other hand, China fell from 13% growth in GDP to about 6% also. India was clearly producing more stable growth in a turbulent time. Futhermore, it did enact a modest stimulus program of some $80 billion while China put forth a massive stimulus public works program of $600 billion, massive given the size of the country.

India is a major source of labor which is outsourced to other countries, especially the US. I receive frequent emails offering accounting, tax, and other outsourced services at very reasonable rates. But to think that India is a major exporter like China would be a mistake. In fact, India has a nice balance between imports and exports whereas China is export-driven. In recessionary times when exports fall off, China's economy is more votatile, a point made earlier. Whereas China is trying to move to a more consumption-based economy to bring more stability to the country in difficult times, India is already there in terms of a consumption-driven economy.

Savings and Investments

India has achieved a savings and investment rate of 35%, putting it on a very competitive path with China which has a rate of approximately 40%. Not to be overlooked though, these countries do not have a social security retirement system, so workers have to save for their own retirement. Obviously, there is some difficulty in obtaining accurate numbers from countries which may play around with the numbers or, worse, hid them. Direct investments by foreign businesses into India rose to 2% in the middle of the global recession. This suggests that foreigners see opportunities and have a certain level of confidence. India's capital efficiency is similar to China's and there are fewer obsticles to doing business in India.

Feeding India

If foreigners could point to one disadvantage to investment in India, it would be the relative poverty driven by inadequate food supplies. Monsoons, excessive regulations, inefficiency, and lack of infrastructure are seen as responsible for this situation. India employs about two-thirds of its population in food production, but food production contributes only 20% to gross domestic product. In addition to the above mentioned problems, India invests a mere 3% of its income to building up this sector of the economy whereas China invests about 6%. These percentages are similar for output as well. Again, China is outstripping its neighbor. Mr. Asnani estimates that ratcheting up investment to that of China could add at a minimum 1% to GDP growth. Better food production could help stablize prices in India, and that might help stablize interest rates, which in turn would promote higher investment rates and higher GDP growth rates. Technology to raise food production is readily available in the world today. Obviously, the will of the nation to change policies and politics could move it forward.

Budget Deficits

Public debt in India is 66% of gross domestic product, not particularly conducive to internal growth. One quarter of bank deposits made to Indian banks winds up financing the debt issued by the government. Sounds like the United States, Greece, Portugal, Spain and Italy, just to name a few countries in the same boat. Compared to China, this is a distinct disadvantage. Furthermore, India's government expenditures are lower as a percentage of GDP than China. You would think that would be an advantage. The problem is China is able to collect the taxes to pay for its government expenses whereas India has a problem with tax collections. Mr. Asnani should be familiar with the propensity of Indians to avoid or evade taxes. Not that the Chinese aren't of the same ilk. It just seems that the problem is more pronounced amongst the Indians.

Private Sector Growth

The private sector contributes approximately 75% of India's GDP while China's tightly controlled private sector contributes only 66%. You can see the advantage of not having government as the largest employer. That is not the trend in the United States. As a result, India is far more democratic than China. In fact, in India, privately owned businesses make up 75% of the market capitalization of India whereas in China it is only about 20%. Foreigners find it easier to invest and operate in India whereas that's not the case in China. Just ask Google.    

Not only does India have a larger private sector, that sector has been around longer than the private sector in China and they have had a more accomodating government than China. Consequently, brand names more powerfully drive the consumer market in India whereas the brand names in China may have longer to go to establish themselves in the minds of the Chinese middle class.

Other Considerations

The speed of urbanization is much faster in China. Hence the speed of infrastructure is faster. It has to be to keep up with the population shifts. With the population shifts comes demand for housing and China is trying to keep up with its rapid change. Not so in India where the speed of population shift to cities is about half that of China. Maybe that's a good thing, not requiring as much government spending and heavy debt financing. On the other hand, the economy runs on the ability of individuals to communicate both in person and by wire.

Another area that India is trying to play catchup to China is in the establishment of special economic zones where special tax-related incentives are given to business development. China is the clear leader in developing information technology and service businesses. India has a ways to go to develop IT, but they excel in exporting services.

From India, the Latest Management Fad (Reena Jana, Newsweek, December 14, 2009)

IIndia had a 7.9% growth rate in Q3 of 2009. The reason some think: jugaad (pronounced joo-gaardh). Jugaad means a style of innovation driven by scarce resources and attention to a customer's immediate needs, not lifestyle wants. Jugaad has been used in India for a long time and its obvious why this strategy is suited to India: lack of cash. Although critics might claim that this leads to shoddy service due to cutting corners, the idea is spreading to US companies, also strapped for cash after a brutal recession. Tata Group, Infosys Technologies, and other Indian companies have gained international stature using jugaad. Best Buy, Oracle and Cisco are examples of US companies applying jugaad. The Unversity of Michigan's Ross School of Business has opened an office near Infosys's headquarters in India to observe first-hand how jugaad is working. The writer did not indicate that China was apply jugaad. As far as we are concerned 7.9% growth in one quarter is pretty darn good.

What's Holding India Back (Mehul Srivastava, Newsweek, October 19, 2009)

There are over 200 projects on tap that could move India convincingly into the 21st century, but standing in the way are the landowners and the politicians. The state has the right to take property by some process similar to our eminent domain laws. The farmer/landowners will fight to keep the state, and we're not talking about town meeting fights. We're talking hand-to-hand combat. Politicians don't want to evict voters. Another problem: the government will only give a landowner 5 acres, no matter how much acreage he has been forced to part with. A further problem is the market for farm land is thin, meaning there are not enough transactions to establish fair market value.  So everything is on hold, including better growth. Some 280 million Chinese work in factories while 45 million Indians do. In other words, Indians are resistent to entering the industrial age in a big way. Without solving this problem, India will always be playing catchup to China. With so much growth being held up, playing catchup will a loser's game.

Conclusion

China and India both have their strengths and weaknesses and can learn from each other. Investors can learn by allocate dollars to both areas. At present, we have twice as much allocated to China, but during the latter half of 2009 and the first quarter of 2010, India has outperformed. Allocation is a matter for continuous review, as change develops in both countries.